The cheap shares UK small-cap star has been buying

The UK small-cap manager of one of interactive investor’s Super 60 picks has been buying out-of-form shares. 

The unloved UK market is creating value opportunities for small-cap star manager Neil Hermon, who has recently added three new holdings to the Henderson Smaller Companies (LSE:HSL). The trust is one of interactive investor’s Super 60 choices. 

Year-to-date, Hermon has opened small positions in brewery Young’s & Co (LSE:YNGA), legal and professional services provider Knights (LSE:KGH), and cellular materials maker Zotefoams (LSE:ZTF). He has been taking advantage of depressed valuations in the UK small-cap market as both international investors and UK retail investors shun the space. 

“New names that have been added to the portfolio are opportunities driven by rapidly declining share price or liquidity opportunities,” says Hermon. 

“The declines in equity markets have provided some very interesting buying opportunities and some companies will emerge stronger from the downturn. However, it is important to be selective as any recovery will be uneven, and strength of franchise, market positioning and balance sheet will determine the winners from the losers in a post-Covid-19 world.”  

• Record investor exodus from UK funds
• These UK smaller companies are in rude health
• Ignore UK’s smaller companies at your peril

UK shares unloved

Covid-19 and Brexit fears have turned investors away from the UK market and put downward pressure on valuations, which remain well below their normal levels, adds Hermon.

• Invest with ii: Top Investment Trusts | Share Prices Today | Open a Trading Account

“Sentiment towards the UK this year has been poor and, overall, UK equities are relatively unloved at the moment. Outside of Covid-19 there remains the issue of Brexit negotiations as well, the result of which remains unclear at this point.

“In terms of valuations, the equity market is now trading well below long-term averages and in a market where valuations are depressed you would expect to see M&A occur, but we aren’t seeing much of this activity at the moment,” he says. 

• Ten ‘magic formula’ stocks for investors looking for value and quality
• Finding small caps that could be tomorrow’s giants
• Take control of your retirement planning with our award-winning, low-cost Self-Invested Personal Pension (SIPP)

‘Growth at a reasonable price’ 

The manager’s investment approach is to look for “growth at a reasonable price” (GARP). He has been striving to maintain this strategy and ensure the portfolio remains balanced, taking at least a two to three-year forward view in the face of economic uncertainty.

He notes that the pandemic has “dramatically” changed the outlook for global growth, while lockdown measures are having a profound impact. Consequently, market participants are thinking short term, and there is little clarity on the shape of any potential recovery. That said, the manager sees interesting investment ideas among the UK’s smaller companies as investors and consumers get to grips with a new way of life. 

“Although economic conditions are very difficult at this point and the economic impact of the much-used term ‘new normal’ is something investors are still grappling to understand and quantify, the smaller companies market continues to throw up exciting growth opportunities and we remain confident in our ability to generate value from a consistent and disciplined investment approach,” he adds. 

The Henderson Smaller Companies investment trust is one of interactive investor’s Super 60 choices. It has returned 42.9% over five years against a sector average of 29.4% and is currently trading on a 7.1% discount to net asset value, according to FE Analytics.